As not-for-profit organizations expand their reach, many are unaware that they may be creating nexus in states where they have previously had a limited presence. Here’s what they need to know.
State nexus and compliance for public charities and private foundations has been a long-standing issue, and as these not-for-profit organizations are able to expand their reach through technology and other means, state requirements for not-for-profits are also increasing. Many not-for-profits do not know that the states in which they conduct business have many rules that may apply to them.
State and local governments are actively interested in the charities that operate within their borders to ensure that the organizations’ assets are used for their intended charitable purposes and to protect their residents from being fraudulently solicited for donations. These governments are also interested in the financial gain from regulating charities. They may impose fees on the not-for-profit organizations based on their size (or other factors). In addition, if a not-for-profit organization has income from business unrelated to its exempt purpose, both the federal and state taxing authorities want to make sure they receive their share of any taxes on that income.
Not-for-profit organizations should consider the following factors before beginning any business activity within a state, to address the increased scrutiny of state and local authorities.
1. Interested parties: The organization’s audience
Becoming compliant with the laws of state and local jurisdictions is increasingly important because of the accessibility of information to the general public. Several interested parties could be actively seeking information about the not-for-profit’s status with various states, including:
• The IRS;
• Foundations and donors;
• Researchers and watchdog groups;
• News media; and
• State agencies and other federal agencies.
While the searching activities for the above groups are unknown, the information is available to them. In their efforts to increase revenue and protect their residents, it is probable that they would use what is readily available. In addition, the IRS and many states are sharing information about not-for-profits. Further, potential donors often use information from their state to ensure the organization is in compliance with state laws and not a fraudulent enterprise.
2. Federal tax law requires compliance with states
Regs. Secs. 1.6033-3(c)(1) and -2(a)(2)(iv) require private foundations to furnish a copy of their annual Form 990-PF, Return of Private Foundation, to the attorney general of the following places:
• Where the organization’s principal office is located;
• Where the organization was created or incorporated;
• Any state the organization reports to concerning its organization, assets, or activities; and
• Any state where the organization has registered (or otherwise notified the state) that it intends to be (or is) a charitable organization or holder of property devoted to a charitable purpose.
While this federal requirement does not explicitly apply to public charities, if the state requires a copy of the Form 990, Return of Organization Exempt From Income Tax, the organization must comply. In fact, Form 990 contains a list of states in which the form is required to be filed.
Public charities should be careful to send only the public disclosure copy of Form 990 to the states to ensure that donor information (contained on Schedule B, Schedule of Contributors) and other sensitive information are not released to the public. States often publish the Forms 990 on a website or send copies to those who request them. Generally they do not check to be sure that a public disclosure copy was sent.
In a recent case (Center for Competitive Politics v. Harris, No. 14-15978 (9th Cir. 5/1/15)), the Ninth Circuit upheld a California regulation requiring charities that are registered to solicit contributions in the state to file a nonredacted copy of Form 990, Schedule B. California maintains it does not make Schedule B available to the public, but, even so, organizations should be aware of the potential exposure in California and the need to provide only the required copy to any other state that requests it.
3. Regulating solicitation and annual compliance requirements
A solicitation is defined as any request for a contribution, through any medium, i.e., asking for a gift or selling goods or services. If the organization is soliciting or conducting business, it may need to register with one or more offices within a particular state. Conducting business could mean a variety of things—including solicitation, having property or employees in the state, or selling goods or services in the state. The organization will also need to renew its status annually, which might include a simple postcard filing, a tax return filing, or filing an online form describing the organization’s activities and financial information.
Some organizations may be exempt from filing with a particular state. Although the exceptions vary from state to state, exemptions often apply to religious organizations and organizations that have raised less than certain amounts in the state.
As part of the requirements to register to solicit donations, states such as North Carolina require specific disclosures on their solicitations, written acknowledgments, receipts, and advertisements. Most state disclosures let the donor know where to find financial and registration information about the organization. Note that many states also regulate fundraising professionals (professional solicitors); the rules vary by state.
It is important, once an organization registers with the state, that it maintain its annual compliance. Many states are issuing severe penalties for noncompliance. And these states are hesitant to provide relief from penalties, even to small organizations (and are sometimes prohibited from doing so by law).
4. Sales and use tax
Tax-exempt organizations must comply with each state’s sales and use tax rules much as for-profit businesses do. The analysis to determine whether an organization has sufficient nexus to be required to collect and pay over sales taxes is the same for a not-for-profit organization as it is for a commercial business entity. In general, not-for-profit organizations collect and remit sales tax for taxable sales. For example, if an organization sells T-shirts with its logo on it, this is usually a taxable sale, and sales tax must be collected and remitted to the state where the sale takes place.
The good news is that some states provide sales tax exemptions to not-for-profits for purchases, which is a valuable tax benefit when organizations purchase supplies or other items or services. This often overlooked benefit could save qualifying organizations 5% to 9% on purchases.
5. Unrelated business taxable income (UBTI)
According to the IRS, more than 45,000 Forms 990-T, Exempt Organization Business Income Tax Return, were filed for the 2011 tax year (IRS, Statistics of Income Division, Tax Exempt Organizations, Unrelated Business Income (October 2014)). Many not-for-profit organizations have income from activities unrelated to their exempt purpose (UBTI) or are considering engaging in those activities for additional revenue. Having income from business unrelated to an organization’s exempt purpose comes with additional state income tax compliance issues. In fact, most states conform to the federal income tax definition of UBTI and impose corporate income tax or state unrelated business income tax on state-sourced UBTI.
It is important for a not-for-profit to know whether it needs to file in a particular state. If the organization is not otherwise doing business in the state by soliciting contributions, then it should analyze whether it has income/franchise tax nexus in the state from specifically generating UBTI. If an organization is already registered with the state to solicit contributions, then it would need to apply the appropriate apportionment of UBTI to that particular state, if any, to determine whether it must file a return in that state. However, not-for-profits often have unrelated business losses, so it may be prudent to file in a particular state to preserve a loss that may be carried forward against future income. Note that even when an organization does not have UBTI, it may need to apply for exemption from certain state income and franchise taxes (e.g., North Carolina and California).
It is noteworthy to mention the complex matter of alternative investments (such as limited partnerships, real estate funds, and private-equity funds), which not-for-profits frequently use hoping for higher returns. (For a discussion of this issue, see Evans and Hall, “Are Alternative Investments Worth Their SALT for Tax-Exempt Organizations?”46 The Tax Adviser 416 (June 2015).)
The bottom line
States are increasingly looking for more revenue and to protect their residents from fraudulent organizations by stepping up their regulation of not-for-profits. This increased attention gives not-for-profits an opportunity to further their mission through transparency while maintaining balance to provide only what is required of them. Preventive action is crucial when reviewing multistate activities and related compliance requirements. Not-for-profit organizations are well-advised to review their activities with their CPA and legal counsel to determine the requirements they must meet in each state.
For questions on compliance for Not-for-profits, contact Andrew Gray, Tax Supervisor, at firstname.lastname@example.org.
This article was republished with permission from The Tax Adviser, an AICPA publication, on August 18,2015.